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29.01.2019 01:46 PM
Fed provokes storm

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Voting for the draft agreement on Brexit postponed to February 13, Theresa May promised to make adjustments to the document to increase the chances of success. Judging by the active purchases of the pound since mid-January, investors are waiting for a favorable outcome. But the decline of the British currency against the euro and the dollar should not be ruled out, as it is not yet clear what the draft document will be for the next vote.

Traders are concentrating on two other events, the Fed meeting and the US-China trade negotiations. According to some market participants, the narrowing of the Fed's bond portfolio was the cause of volatility in stock markets. Such a conclusion puzzled members of the Central Bank and other financiers, since there is no crisis in both areas where the regulator often intervenes.

The US Central Bank reduces its asset portfolio by $ 4 trillion, allowing for the redemption of bonds and mortgage-backed securities without reinvestment. Each month, the program provides for the redemption of liabilities up to $ 50 billion, while the figure was previously at $ 40 billion.

In 2017, the markets gave a minimal response to the announcement of the program, and recently many reputable players, including Stanley Druckenmiller, argue that the contraction of the portfolio is one of the main causes of volatility. Donald Trump, because of fluctuations in stock prices, advised the Central Bank to abandon such a venture.

According to Scott Minerd, director of investments at Guggenheim Partners, "this changes the psychology of investors."

The Fed is reducing its bond portfolio at the same time as the Ministry of Finance issues bonds to cover a large deficit, he noted. The overall effect, more than $ 1 trillion of government bonds and mortgage-backed securities come to the market, squeezes out capital from other investments.

CB denies

A representative of the regulator and other economists in public comments deny the fact that the contraction of the portfolio significantly increases market volatility. Recently, long-term interest rates have been falling, rather than rising, indicating strong demand for new treasury bonds, they explain. In addition, the repayment program is much narrower than the volume of new obligations that are needed to cover the increasing deficits.

The yield on 10-year bonds fell to 2.75% from 3.25%, recorded in November, when market volatility was on the rise.

The program to buy the Fed's securities, launched 10 years ago due to the financial crisis, is aimed at stimulating the economy by containing long-term rates. Lower rates provoke investors to buy risky assets, including stocks, corporate securities, and other assets, thereby boosting their growth.

Concerned about the decline in balance, they are confident that the purchase of bonds has well stimulated the interest of market participants in risky assets. Currently, the curtailment of the program also discourages investors from taking risks, but with a delayed reaction.

Rates and balance

It is not easy to separate the effect of lowering the balance and raising the rates of the US Central Bank on financial conditions. Last year, the cost of lending was increased 4 times, each time by a quarter percent, in December, the rate approached 2.25-2.5%. At the two-day meeting that started today, the Fed is unlikely to change the rates, but it will touch on the subject of reducing the balance.

According to Natixis Bank experts, a decline in the balance sheet may be equivalent to a 0.5% increase in the short-term rate. Some investors experienced discomfort and anxiety about the bond portfolio after the signal about the general attitude of the Central Bank in relation to rates and the economy. The market can take a strong commitment to reduce assets in the portfolio for a hint of the willingness of the regulator to withstand high rates while economic growth is slowing.

Jerome Powell on the eve attempted to eliminate these fears. He argued that the decline in the balance sheet was not a serious factor affecting the market turbulence that began at the end of last year.

The Fed has everything under control

According to Powell, if the bank came to a different conclusion, then "without the slightest hesitation would make the appropriate changes."

The majority of respondents The Wall Street Journal shares the words of the head of the Central Bank of the USA. Half of the respondents believe that the regulator's policy "had little or even zero effect on financial conditions, while 44% called the measures of financial officials relevant to the markets. They were considered "extremely important" by 5% of economists.

Note that the narrowing of the balance sheet could lead to a drop in the value of assets and toughening of financial conditions against the background of the movement of reserves in the banking system, accumulated during the purchase of bonds. Reserves are banks' deposits on the Fed's balance sheet, with which you can assess the security of the financial system with capital.

This channel also has no significant effect. The reduction of reserves has been going on since 2014, and the stock market has been growing most of the time in the last 5 years. Prior to last week, reserves reached $ 1.6 trillion compared with a peak of $ 2.8 trillion in 2014.

And yet, there is little evidence that the reduction in reserves in the banking system has worsened the growth of lending. In the fourth quarter, the indicator approached multi-year highs.

According to the chief economist of JPMorgan Michael Feroli, it is pointless to believe that the decline in the Fed's liquidity level is reflected in the markets. "Many years ago there were widespread fears that the Fed would flood the world with dollars, and these fears were ultimately in vain," he concluded.

Natalya Andreeva,
Analytical expert of InstaForex
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